The Stewardship of Wealth: Successful Private Wealth Management for Investors and Their Advisors, + Website

Chapter 15

Investing in Hedge Funds

Buying stocks long is to selling stocks short what touch football is to Iwo Jima.

—Dave Barry (paraphrase)

Because most taxable investors have a strong capital preservation orientation, and because many hedge funds also have a capital preservation aspect to their activities, it is hardly surprising that hedge fund investing has proven to be extremely popular among affluent families. In the past 20 years, hedge fund investing has gone from a fringe activity practiced by obscure gnomes to the most rapidly growing of all investment opportunities.¹

Today, there are at least 8,000 hedge funds in existence, and probably more than 10,000. Note that this is far more than the number of stocks listed on the New York Stock Exchange. In an average year, hedge fund managers generate more income than all the mutual funds registered in the United States. Indeed, what used to be exclusively the province of wealthy and institutional investors is now hot retail territory. “Retail” hedge funds of funds offered by large financial institutions and requiring very low minimum investments are sprouting everywhere, and there are also mutual funds that invest in hedge funds or that attempt to replicate hedge fund strategies.

Why are hedge funds so hot? Partly, of course, it's the mystique that surrounds hedge funds. They are exclusive, nontransparent, and engage in exotic kinds of investment strategies. Families who invest in hedge funds feel that they are somehow ...